Watch the Gaps in the E-mini

I have often said that the S&P futures contract is "the tail that wags the dog known as the U.S. stock market." That is generally true, but sometimes it's more evident. Now is one of those times, so it behooves the short-term trader to keep close watch on the futures. For our purposes, I will highlight the March E-mini, as it's more widely followed and more widely traded than the larger S&P futures contract.

Another one of my favorite sayings is that "one gap begets another." That's what we saw on Monday when the market sold off sharply, in the process filling last Friday's gap in the futures from 1492.25 to 1500.00 (there was no equivalent gap in the cash). Then on Tuesday morning (here's the part about one gap begetting another), the futures shot back up, in the process creating another gap in pretty much the same spot as the one from last Friday that had been filled on Monday. That new gap in the futures was 1493.50-1498.75. Again, if you were looking for a gap in the SPX (cash index), you wouldn't have found one, because it didn't occur in the cash, just the futures.

Now, I'm sure that some of you are rolling your eyes right about now and saying, "So what? Who cares?" Well, if you are a trader of the market, you care, or at least you should.

The low in the E-mini, so far today, as of 12:30 Eastern, has been 1494.50. That's 1 point from that gap. And now the market is bouncing off that low. I have been buying SPDR S&P 500 (SPY) calls and even some SPDR Dow Jones Industrial Average (DIA) calls as the market has backed off into the bottom of that gap. I will add a bit more once the gap has been filled in its entirety and likely re-establish some bullish bets in my mutual fund positions at Rydex. I will be betting on a bounce from the bottom of that gap. Maybe the bounce has already begun. If so, that's fine. If it goes a bit lower to fill the gap, that would also be fine, though I wouldn't want to see Monday's low of 1490.25 in the E-mini broken by much.

I have highlighted the E-mini because it tends to lead the market. The other reason I highlight it is that, as noted many times before, the SPX cash often doesn't show the gaps that occur. So from that perspective, the SPX is not very helpful. However, the chart of the SPX does reveal a potential double top at the 1515 level. That's now serious resistance, and it represents the spot to sell against. If you are trading the futures, it's the spot to sell against with tight stops.

For my accounts, it's the area for cutting back in long positions and for writing out-of-the-money March and April calls (which I've been doing for the past couple of days). If that level gives way, then, once again, it puts the Nov. 1, 2007, gap back on the table at 1549, and above that the all-time highs at 1576.09.

Of course, the big story in the mainstream media has been the move up to Dow 14,000. CNBC put on party hats and popped the champagne last Friday when the Dow first closed back above 14,000, but the party didn't last long. Now, here we are, a few days later, and after repeated attempts to get back above 14,000, the Dow has pulled back about 170 points from its new multi-year high. It was also noteworthy that on Tuesday, when the SPX made a fractionally higher high, neither the Dow nor the Russell 2000 confirmed the higher high.

Speaking of the Russell 2000, it was also interesting that the RUT was having a tough time filling its gap from Monday's down opening. That actually happened in the last few minutes of yesterday's trading. Still no higher high here, but that gap at 911.19 was filled yesterday as the RUT topped out pennies above the gap at 911.45, and from there the RUT has backed off.

Then there is the Apple (AAPL) story. Recall in my column of Jan. 24, the day of that big gap-down opening in the stock, I explained that I liked writing the March 410 puts in a range of $4.75 to $5.55. The high in the puts that day was $5.80, which occurred as the stock tagged the $550 level. That seemed like a terrific plan until the next day, when the stock sold off another 15 points to $435. But note, now, a couple of weeks later, as of 1 p.m. Eastern time, the stock is essentially back to where it opened that day, Jan 24, at $558. So if you had bought the stock, you'd be back at break-even levels.

But how about writing the puts? The March 410 puts are now trading at $2.55. That's about half of what I sold them for that day with the stock at current levels. So the stock has gone nowhere in two weeks, while the March 410 puts have been cut in half. What was a better idea? Buying the stock or writing the puts?

Now, by the way, I am hedged in the March 410 puts, as I have purchased some March 425s or March 430s, which are now trading at the same price as the 410s were a couple of weeks ago, in the $5-$6 range. But I have now sold the distant January 2014 310 puts in the $6.50 area. Also sold some of the January 300 puts. Still don't own the stock.

Sentiment is another reason I am a bit cautious on the market here. Too many buyers of calls, and not enough worry about the next shoe to fall. The volatility index (VIX) is popping today, but I need to see it back above 16 before I get very excited about the long side. And that may not happen for a while.

At the time of publication, Schiller was long Mutual Funds at Rydex from 20-35% invested levels. Long junk bond funds at Fidelity. Long AAPL March 410-425 put spreads. Short AAPL January ’14 puts. Long AAPL February calls spreads. Short QQQ March 64 puts. Long SPY and DIA March call spreads.